Debt consolidation and fiscal stabilization of deep recessions

The global financial crisis of 2008–09 has sent public debt on sharply higher trajectories, as governments have provided large-scale support to the financial system, implemented discretionary fiscal stimulus, and accommodated steep drops in tax revenue. With the economic recovery gradually taking hold, the focus is now shifting to fiscal “exit strategies.” Indeed, many countries are set to face significant retrenchment in government spending over the medium term. In the US, for example, the Obama administration’s 2010 budget pledges to “cut the deficit in half by the end of [its] first term, and [to] bring non-defense discretionary spending to its lowest level as a share of GDP since 1962”; see Office of Management and Budget (2009, p. 1). Similarly, the UK government’s December 2009 Pre-Budget Report foresees large medium-term deficit cuts, with two-thirds of the fiscal effort on the expenditure side. Figure 1 shows the outlook for discretionary spending as interpreted by the two countries’ respective fiscal watchdogs.